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Please Be Careful With GameStop Stock

By Anders Bylund - Updated Jan 26, 2021 at 10:54AM

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The video game retailer has become a piece in a massive stock market game in recent weeks. This one has a dark ending.

Video game retailer GameStop (GME -7.09%) is an incredibly popular stock right now. Share prices rose 354% in the last two weeks, reaching an intraday 14-day gain of 612% on Monday, January 25. Trading volumes also soared during this period. GameStop's stock typically sees about 7 million shares changing hands on an average day. Last Friday, the volume skyrocketed all the way to 197 million shares.

You need to be careful with this insanely volatile stock. This is not the start of a long period of healthy gains but a warning sign of the equally impressive GameStop crash that is looming right around the corner.

A businessman buries his head under a laptop, holding a white flag reading "Help!"

Image source: Getty Images.

A handcrafted short squeeze

GameStop has been a magnet for short-selling interest for a while. The company has 47 million shares available for trading on the public market, also known as the stock's "float." As of December 30, 71 million shares have been borrowed by short-sellers. Shorting can exceed the actual number of available shares under some circumstances, and that's what's going on here. Simply put, GameStop is one of the most heavily shorted stocks on the market.

A group of day-trading enthusiasts on the online discussion service Reddit saw GameStop's short-sale ratio climbing in 2020 and combined that trend with activist investor Ryan Cohen's large investment in GameStop. Cohen's presence, just before the long-awaited launch of two new gaming consoles over the holidays, drove GameStop's stock price much higher.

So Reddit's day-traders planned a veritable coup that went live on January 11. What started as a legitimately positive reaction to Cohen's venture fund grabbing three seats on GameStop's board of directors became the opening salvo in a concerted price-boosting effort. The stock gained another 78% on January 22, and the short squeeze continued to accelerate on Monday.

That's where we are today. All told, GameStop's stock has now gained a spine-chilling 2,000% since the market bottom in March.

That's not a thrilling win. It's just a long way down from here.

A red charting arrow and four coin stacks trending downward.

Image source: Getty Images.

What's next for GameStop?

This is not a sustainable jump. The driving forces behind this monumental short squeeze are temporary in nature, and the high prices can last only as long as the Reddit traders are able to keep up the pressure. You might recall when German car maker Volkswagen (VWAGY -3.36%) suddenly became the most valuable stock in the world thanks to a massive short squeeze in October 2008. One month later, Volkswagen shares had lost 63% of their peak value as the speculation that led up to that spike faded out.

GameStop's shares will do the same thing. The day-trading crowd has achieved its mission and is now ready to move on to another heavily shorted target. If nothing else, it has given a valuable lesson to the rest of us. Selling stocks short is a risky game with limited gains and potentially infinite downside. A so-called margin call will force many short-selling traders to lock in their losses at the worst possible time, maximizing the damage to their wallets. That's the exact opposite of investing in high-quality companies for the long run, whereby your losses are limited to the money you invest but the potential returns can make you rich.

GameStop is still a struggling business that should count itself lucky if it's even around five years from now. The big gains in recent weeks will soon melt away, leaving a lot of disappointed investors in their wake. Forget about GameStop and look for some genuinely incredible businesses instead. I have a few ideas for you.

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